A Sceptical Take on the Financial Crisis

By no means am I denying that the world is in some pretty deep financial you-know-what. But from where I’m seeing things – mostly from my computer in London – there appear to be several potential misconceptions about the entire crisis about how it began, how it will end, the people involved in it and how bad it is. I’ll admit that I don’t read the FT every day. However from the few financial RSS feeds I’m subscribed to and the occasional article I read in the Economist or Moneyweek, I keep feeling instinctively compelled to draw conclusions which I don’t think necessarily ring true and increasingly feel the need to stop and wonder whether the journalism I’m being fed really represents what is going on out there in the real business world. I’ve always been advised not to believe what I read, so here’s me questioning it.

Doom Prophets aren’t all geniuses

Newsnight (BBC), Squawk Box (CNBC) and various other financial and news programmes seem incredibly fond of bringing in various great geniuses who supposedly predicted this crisis for interviews. I have no doubt that there are people out there with a far superior understanding of the market than even the most experienced bankers, and that indeed some of them did predict this crisis. However with a new doom prophet appearing on CNBC practically every week I begin to wonder whether some of these people just got lucky. While it may seem ridiculous to suggest that someone who predicted such an apparently surprising turn of events did so purely out of luck, it is a fact that every economic system ever devised has had problems with it which would result in some amount of instability, be these problems due to imbalance of power or wealth, or some cyclic boom/bust sequence. If such a perfect system did exist which somehow balanced fairness with economic efficiency and stability and utilitarian (or otherwise) happiness (or utility, if you like), it would surely be in place somewhere, if not everywhere in the world. The so-called doomsayers therefore only have to pick one of these problems and hope to be proven correct. Since there is a limited number of obvious problems which can lead to a disaster, when that disaster happens, chances are that there will be a substantial handful of people who hadn’t a clue what they were doing yet still managed to predict it. I reiterate my previous disclaimer: I’m not saying every doom prophet was playing dice with his predictions; I’m merely pointing out that with such a large base of doomsayers, it’s statistically probable that when something happens someone will have got it right.

It’s not -that- bad

Reading the news and scrolling through the business section of the BBC website (or looking at the RSS feed), I can’t help but notice the frequency of articles containing painful details of firms laying of thousands more workers, or taking severe losses, or going into administration – the list goes on (almost) ad infinitum… There was an interesting post on Lifehacker a while back about information overload due to the financial crisis. As media become increasingly efficient at broadcasting the only type of news that customers love: bad news, the average citizen becomes increasingly over-alarmed at increasingly over-dramatised situations. My mum for example has an interesting impression of the world: she advised me not to respond to a snowball thrown at me for fear that if I throw a snowball back the original thrower in question would pull out a gun and shoot me. This I hope is an extreme example and I’m more than sure the crisis is dead serious. However the amount of dystopian news/journalism flooding into my brain through my eyes and ears every day does seem to suggest the picture isn’t quite as black and white as the BBC says it is.

Maths works!

I was actually quite outraged when I woke up one morning to hear Nick Ferrari denouncing Mathematics as the cause of the financial crisis and going on proudly to broadcast to London’s Biggest Conversation his ineptitude at all things numerical. Of course I had heard of how financial mathematical models had failed to take into account risk as they should have done. However from what I see of comments on financial articles, statisticians appear to have become even more unpopular than CEOs, and I cannot sit back and accept this. I believe it’s not the Maths that was at fault. The models that were created were perfect considering the assumptions made by the quantitative analysts and theorists who dreamt them up in the first place. If all the assumptions made were true, a perfectly-constructed mathematical model would have always provided the best answer possible. In fact, even the people who came up with the models, on the whole, aren’t to blame in my opinion. They were forced by the complexity of the problem to make certain assumptions. With the market so chaotic, what option did they have but to model it as a basically stochastic system? The people who really are at fault are the ones who chose, with incomplete knowledge of the Mathematics, to act upon the results of it. Michael Hintze, head of CQS, apparently once said something to the effect that ‘Maths is a great place to start but a terrible one to end’. I couldn’t agree more: Mathematics functions under the general rule: Garbage In, Garbage Out. It will work perfectly given perfect data. But owing to the incomplete nature of information in the market, it simply cannot be relied on as much as those who did rely on it thought it could. So rather than complaining about how Maths has failed the world, Nick should have been complaining about how it was abused to the point of disaster.

We won’t do this again, promise

There are occasional optimists who claim that the situation we’re all in at present is good for the world in the long run. The line of argument often quoted is something like ‘we will learn from this’ and so ‘the world will become a better place’. The idea is that market failure and economic disaster may be averted in future owing to great revelations during this slight blip. There was a person last year who came to talk at St Paul’s who pointed out that ‘better’ is a very subjective word when it comes to technology. He used the example of sending a man to the moon. Back in 1969 it took an 8-bit computer, some pretty good theory and some enthusiasm on the part of a NASA team to beat the Russians to send a man to the moon. According to the speaker (apologies as I have forgotten the name) the red tape that would need to be dealt with in order to send a man to the moon now would be impenetrable and it would be highly unlikely for NASA to fund a trip to the moon. There are also several advantages of CRT screens over LCD screens which have been lost such as wide viewing angles and low latency. Omnipresent surveillance is also a direct result of improved technology although some would argue the Labour government has more to do with that. The speaker’s argument was that rather than progressing linearly, some things get better and some worse as technology advances, and progress can be seen more as a rotation than a step forwards. I suspect the same happens with Economics. Bloomberg was a huge hit, yet it has made trading so much more complicated and made it so much harder to make money against a semi-automated market brimming with information. Whether that is a step forwards or backwards is up to you to decide. Returning to learning lessons, the government can’t be everywhere at once and watchdogs and regulators won’t be able to prevent the inevitable cycle of boom and bust which seems to be a feature built into Capitalism. After all, since when has man learnt lessons from his mistakes?

Will the world ever learn?

So to conclude, all I’m saying is that I think the truth is somewhat different to what most people interpret from what they read in the Financial Times LEX Column. As Moneyweek exaggerated, generally speaking there is no such thing as a ‘good investor’, merely a lucky one. Mathematicians cannot and should not be held responsible for misuse of their work, and the future will not necessarily be a better place because everyone has somehow learnt lessons. We will probably not learn enough from this, or any, crash/recession/depression/[whatever state of badness it is now] to avert all possible future crises. I guess the moral of the story is not to believe everything you read. Or perhaps simply to read less into what you read. Or perhaps simply to read less!